Outside Business Activities and Selling Away

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Outside Business Activitiesand Selling Away
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Definition Outside Business Activity

• The engaging, by an agent, in an activity which
  does not include the sale of securities, outside
  the regular course or scope of his employment.
• Requires prior written notice to the broker
  dealer.
• Although written authorization is not required,
  most firms have, as part of their supervisory
  procedures, a requirement to provide written
  authorization to the agent prior to engaging in
  the activity.

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Governing Rules

• NASD Conduct Rule 3030
• Outside Business Activities of an Agent

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NASD Conduct Rule 3030

• No person associated with a member in any
  registered capacity shall be employed by, or
  accept compensation from, any other person as a
  result of any business activity, other than a
  passive investment, outside the scope of his
  relationship with his employer firm, unless he
  has provided prompt written notice to the member.
• Such notice shall be in the form required by the
  member.

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Provisions of the Rule

• An agent who engages in an outside business
  activity without prior notice to his or her firm,
  including the sale of non-securities products,
  violates NASD Rule 3030.

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Firms Responsibilities

• Supervisory procedures should be reasonably
  designed to achieve compliance with NASD Rules
  3030 and 3040 regarding outside business
  activities and private securities transactions
• Appropriately educate their agents regarding the
  requirements of Rules 3030 and 3040.

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Examination StepsOutside Business Activities

• Do the firms supervisory and compliance
  procedures appear to be reasonably designed to
  prevent and detect outside business activities?
• Does a review of the firms records indicate that
  agents notified the firm prior to engaging in the
  activity?

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Examination Steps cont.

• Does the firm require agents to affirmatively
  disclose, on a periodic basis, their outside
  business activity(ies)?
• Review agent files for such records and determine
  whether it was subsequently reviewed and
  approved/denied by the firm
• Review annual compliance questionnaires
• Does the firm independently verify the
  disclosures on the questionnaires?

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Elements of Outside Business Activity Violations

• Activity does not include the sale of securities
• Agent failed to notify the firm in writing prior
  to engaging in the activity

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Outside Business Activity Examples

• Outside business generally includes engaging in
  activity which does not include the sale of
  securities outside the scope of the firm
• Examples requiring prior notice to the firm.
• President of homeowners association
• Member of the audit committee of a church
• Real Estate sales
• Mortgage Broker
• Tax Preparation

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Outside Business Activity Supervision

• As part of the supervisory and internal audit
  program, the dealer should have a procedure to
  ensure the agent does not engage in any activity
  denied by the firm.
• Likewise, the examiner should confirm that
  activity denied by the dealer, did not occur.

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Definition Selling Away

• The engaging, by an agent, in a private
  securities transaction outside the regular course
  or scope of his association or employment with
  the dealer he is registered with, without prior
  written notification to the dealer with whom he
  is associated.

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Governing Rules

• NASD Conduct Rule 3040
• Private Securities Transactions of an Associated
  Person (Agent)

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Provisions of the Rule

• Rule 3040(b) requires written notice to the
  broker dealer and written approval from the
  broker dealer to the agent prior to engaging in
  the transaction(s).
• In transactions which involve compensation, Rule
  3040(c) requires that the dealer approve or
  disapprove of the transaction(s) in writing and
  record the transaction and compensation on its
  books.

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Provisions of the Rule cont.

• In transactions which do not involve
  compensation, Rule 3040(d) requires that the
  dealer acknowledge in writing receipt of the
  agents notice.
• The broker dealer is required to supervise the
  activity in connection with the sales by the
  agent.

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Elements of Selling Away Violation

• The product sold is a security.
• The agent did not provide written notification to
  the broker dealer and/or receive approval.
• Transactions involving compensation were not
  recorded on books and records of broker dealer.
• In transactions which do not involve
  compensation, the firm did not provide written
  acknowledgement to the agent.

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Proof that Product is a Security

• Documents given to investor(s) to evidence
  ownership such as contract, note, stock
  certificate, canceled check, bank records of
  issuer, etc.
• Analysis by examiner, attorney, or expert that
  the product sold is a security.

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Proof of Written Notification and Approval

• Section of dealers procedures manual which
  outlines steps for submission and approval.
• Documents evidencing request by agent and
  approval/denial/acknowledgement by firm, or
  letter from compliance that no such requests were
  made.
• Interview of agent and compliance officer.

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Proof that Transaction was not Recorded on Books
and Records

• If compensation was received, review commission
  records of dealer and agent to determine if
  compensation was recorded.
• Statement from agent, supervisor and compliance
  personnel that compensation was not recorded.

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Examination Steps Selling Away

• Review your states corporate records prior to
  your exam to determine any affiliated companies
  of individuals located at the home or branch
  office.You may also conduct other searches such
  as Google.
• Interview branch manager/principal regarding
  firms procedures to prevent selling away.
• Review supervisory procedures manual for selling
  away procedures.

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Examination Steps (cont.)

• Review customer files for indications of the sale
  of securities not approved by the firm.
• Review bank records for unusual bank deposits
  (i.e., commissions) or payments (i.e., interest
  payments to investors).
• Document each selling away transaction with
  check, wire, contract, certificate, etc.
• Interview agent, customer, supervisor, compliance
  personnel, and other interested parties.

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Examination Steps (cont.)

• Conduct on-site visit, if possible, and follow
  examination steps. Otherwise, utilize the
  following steps.
• Review corporate records to determine any
  affiliated companies for individuals.
• Request documents from dealer and agent including
  list of investors, supervisory procedures manual,
  agent file, compensation records, and
  approval/denial documents.

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Examination Steps (cont.)

• Interview branch manager/principal, or get
  written response, regarding firms procedures to
  prevent selling away.
• Review supervisory procedures manual for selling
  away procedures.
• Review agent files for evidence of outside
  business activity.

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Examination Steps cont.

• Does the firm require agents to affirmatively
  disclose, on a periodic basis, selling away
  activity?
• Review agent files for such records and determine
  whether it was subsequently reviewed and
  approved/denied by the firm.
• Review annual compliance questionnaires
• How does firm verify the questionnaires?

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Examination Steps (cont.)

• Interview agent, customer, supervisor, compliance
  personnel, and other interested parties.

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• As part of the supervisory and internal audit
  program, the dealer should have a procedure to
  ensure that agents do not engage in the activity
  denied by the firm.
• Likewise, the examiner should confirm that
  activity denied by the dealer did not occur.

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Other Possible Associated Violations

• Sale of unregistered securities.
• Sale of securities by unregistered agent.
• Fraudulent sale of securities.
• NASD Conduct Rule 3010 Failure to Supervise
  based upon no procedure, deficient procedure or
  failure to enforce procedure

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Other Possible Associated Violations cont.

• FINRA Rule 2010 - A member in the conduct of his
  business, shall observe high standards of
  commercial honor and just and equitable
  principles of trade.

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Do not Confuse Selling Away with Outside Business
Activity

• An agent who sells a security away from his or
  her firm without first obtaining approval from
  the firm violates Rule 3040.
• An agent who engages in an outside business
  activity without prior notice to his or her firm,
  including the sale of non-securities products,
  violates Rule 3030.